Thursday, June 30, 2011

Fiscal expansion is expansionary!

Talk on fiscal policy at the ILO.  The preliminary paper is here.  The graphs I refer to in the talk are at the end of the paper. The link for the other papers presented is here.  The session was on macroeconomic policies for employment creation.

Wednesday, June 29, 2011

Dr. Krugman and the natural rate of interest


So I have said a few times here that, while Krugman has been extremely useful for Keynesians in recent policy debates, as a New Keynesian (neo-Wicksellian would be a better term for this school of thought), he is not properly a real Keynesian.  In a recent post he shows exactly my point.  He says:
"There is still a sufficiently low real interest rate that would produce recovery, but it’s a rate that’s hard to achieve."
In other words, there is a rate of interest that would increase investment and bring about the full employment level of savings.  In this post he surprisingly seems to say that liquidity traps or lower zero bound limits (rigidities) for nominal rates do not matter.

The reason seems to be connected to the fact that creditors must have a positive effect on their net wealth in a deflationary balance sheet recession, and their spending should go up.  Hence, creditors should spend more with a slightly lower interest rate.  Wealth effects have been the traditional neoclassical argument for a self-equilibrating economy since Pigou.  If this were true no fiscal policy would be actually necessary.

It's hard to believe that Wall Street bankers would spend sufficiently more for a recovery to follow.  And I doubt that Krugman believes that this effect is sufficiently strong in the real world.  But he does believe in some sort of natural rate, like Wicksell did, which is compatible with Friedman's natural rate of unemployment.

Keynes, on the other hand, thought that the very concept of a natural rate should be discarded.  In chapter 17 of the General Theory Keynes states that:
"In my Treatise on Money I defined what purported to be a unique rate of interest, which I called the natural rate of interest — namely, the rate of interest which, in the terminology of my Treatise, preserved equality between the rate of saving (as there defined) and the rate of investment. I believed this to be a development and clarification of Wicksell’s “natural rate of interest”, which was, according to him, the rate which would preserve the stability if some, not quite clearly specified, price-level. ... I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment.
I am now no longer of the opinion that the concept of a “natural” rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis."
So, in fact, there might be the case that NO long term rate of interest, a highly conventional one according to Keynes, would be compatible with full employment.  The socialization of investment, in Keynes' terms, then would be necessary.  In other words, effective demand matters in the long run, not just the short run, because there is no tendency for self-adjustment.

Since Friedman's infamous Presidential address to the American Economic Association the neo-Wicksellian approach has dominated macroeconomics.  In this view, the central bank pins the short run policy rate to the long run natural rate, and the economy (save for rigidities and imperfections) moves automatically to full employment.  No fiscal policy is necessary, again with the exception of short run imperfections.  That's why long term considerations about deficits and debt are important. 

My question is: should we be surprised that with this theoretical model as the dominant one, we are in a situation in which the administration is unable to understand and unwilling to promote the fiscal expansion necessary to get us to full employment (or at least lower levels of unemployment)?

PS: Keynes developed the ideas in chapter 17 on the basis of Sraff'a's critique of Hayek's theory of capital in 1932 (here; subscription required).  Note that while Keynes understood that the idea of a natural rate of interest that equalized investment to full employment savings had to be discarded, he did not get that his negatively sloped marginal efficiency of capital actually provided the basis for such a rate.

Tuesday, June 28, 2011

You've been punk'd!


Via Billy blog. The World Bank announced Madelyn Antoncic as its new Vice President and Treasurer. According to the president of the World Bank, Robert B. Zoellick:
“She brings to the Bank an extensive background in the financial industry and a demonstrated record of leadership, innovation, and integrity.”
Yep, she does. She was Lehman’s Global Head of Market Risk Management.  She does have experience with bankrupting institutions!

Monday, June 27, 2011

How do you say devaluation in Greek?


Default is not the dirty word that nobody wants to say. Almost everybody now accepts that Greece will default. Several people will prefer to use the euphemism of “re-profiling debts,” but we all know what it means.  The interesting thing is that at least some authors, like Martin Wolf in a recent column, also acknowledged that default is not sufficient. The surprising thing that almost nobody asks is whether a default would actually solve the Greek problem.

Of course that would require understanding the problem in the first place. And herein lies the problem, since most people still argue that the Greek problem is fundamentally fiscal. In other words, in the conventional view the Greek government spent too much (and lied about it), and the solution must rely on the generation of sufficient fiscal surpluses to pay for the outstanding debt. Further, to obtain the funds it is assumed that austerity is the way to go, privatizing public firms, cutting public sector wages, and reducing pensions.

Read the rest of this entry

Basel III and the BIS

Two news from Basel this Monday. None good. First, in their just released Annual Report, the Bank of International Settlements (BIS) complements the IMF's demands for fiscal contraction, with their own calls for monetary contraction.  In their view:

"Inflation risks have been driven up by the combination of dwindling economic slack and increases in the prices of food, energy and other commodities. The spread of inflation dangers from major emerging market economies to the advanced economies bolsters the conclusion that policy rates should rise globally. At the same time, some countries must weigh the need to tighten with vulnerabilities linked to still-distorted balance sheets and lingering financial sector fragility. But once central banks start lifting rates, they may need to do so more quickly than in past tightening episodes."
It is bad enough not to have sufficient fiscal stimulus in the developed world, but to export the behavior of the ECB to other central banks would be a terrible idea.  In this case, they think that developing countries are exporting inflation, and developed countries should act swiftly.

In part, the misguided recommendation of the BIS follows from an incorrect view of what caused the crisis.  For them low rates of interest now will create new risks in the financial system.  Yet, the crisis was not the result of low rates of interest, but a consequence of deregulation.

And that leads to the second news.  The Basel Committee on Banking Supervision has added a surcharge of extra capital (on top of the Basel III ones) requirements between 1 and 2.5% of the value of risk adjusted assets for large banks (here; subscription required).  I'm sure people more qualified will discuss the nitty gritty details of this proposal, but from my point of view the problem is that this perpetuates large institutions, and avoids the old New Deal commitment to break them up and separate the speculative activities from the financing of productive activities.  There is no reversing of the so-called "revenge of the rentiers."

Sunday, June 26, 2011

Real Wages in Argentina

So there has been some fuss about whether Argentina default was good or not for the economy, because of a terrible article in the New York Times (here). Krugman correctly noticed that this was nonsense and was praised by Dean Baker. I think that it is important to note the role of devaluation (and noted that in comments to both blogs), but wouldn't disagree with Krugman that it's important to emphasize that defaults are not followed by catastrophes and that Argentina is actually a terrible example if one wants to make the opposite case.

At any rate, an Argentine reader (using a pseudonym) got really angry with me, and said some obviously incorrect things about Argentina (and Brazil to boot). But one of his points shows that it is important to clarify at least one fact. The graph below shows real wages in Argentina, with official data, and data from alternative sources that can be obtained in a paper by Roberto Frenkel and Mario Damill (here).



Note that real wages in Argentina have grown irrespective of what inflation index you use. And yes, in Brazil they did stagnate. The recovery of real wages is central to understand, not just the evolution of the economy, but some of the political events that lead to people, like the anonymous blog commentator, to be so angry. But as I told him, using Moynihan's fantastic dictum, a person is entitled to their opinion, not their facts.

PS: The data for real wages comes from ECLAC; the alternative index for Argentina was calculated by deflating the series with the inflation data in the Frenkel and Damill paper.

Friday, June 24, 2011

Nation building

Jamie Galbraith compares Obama speech to JFK's American University speech (here).  And then picks up Obama's preoccupation with Nation building at home and asks:
"President Obama rightly stressed the need to restore our strength and prosperity at home: to create jobs, to rebuild infrastructure, to meet the challenges of energy and climate. In this he called us all to a “common purpose.” Will this vast task now get underway? Will a program follow? Will it dispel the deficit-and-debt doomsayers who degrade today’s economic debates?"
Sadly, I doubt it. How can he do that and try to get more funds for his reelection from Wall Street (read more here)?  Hope springs eternal.

Tuesday, June 21, 2011

Argentina, Ecuador and Greece

Well ... not really about Greece, but this paper that has been finally published on Argentina and Ecuador (in the Journal of World-Systems Research) does say something for the euro area countries in trouble.

From the abstract:
The paper draws lessons from the failed Argentine experience with convertibility to highlight the dangers of dollarization in Ecuador. Argentina’s currency peg to the US dollar was successful in reducing inflation but given the overvalued real exchange rate, created burgeoning twin deficits and a chronic dependency on foreign capital. Ecuador too suffers from chronic current account imbalance. In contrast to Argentina, Ecuador seems to be relying on remittance income to close its external financing gap. Though perhaps this model is less unstable than that of relying on foreign capital it is no more sustainable. The paper closes with a realistic critique of this development strategy.

Mr. Krugman and the Ancients


The preliminary paper posted by Krugman for the Cambridge conference on the 75th anniversary of the publication of the General Theory (GT) is an interesting piece. Not fundamentally for what it says, which is nothing new if you read his blog. Something along the lines liquidity traps imply that you need fiscal policy, and we are at one right now. But it is revealing piece about what mainstream Keynesians understand about the evolution of macroeconomics, and how much knowledge has been lost with the rise to dominance of the neoclassical/marginalist approach.

First, it is important to note that by the time of the New Deal and the Keynesian Revolution American academia was dominated by institutionalism. Mitchell was the head of the National Bureau of Economic Research, John Maurice Clark at Columbia was one of the leading figures of the profession and was the president of the American Economic Association in 1935, and so on. Yes, neoclassical economics dominated in England, with Marshallian traditions in Cambridge, and there were several neoclassical economists in the US, like Irving Fisher, but in America they were still not dominant.

Also, Keynesians or proto-Keynesians like Marriner Eccles and Lauchlin Currie, and institutionalists like Adolph Berle and Rexford Tugwell, were instrumental in bringing a whole generation of economists that where like Clark a mix of institutionalists with Keynesians into the New Deal administration. John Kenneth Galbraith would be the most prominent example. It is important to note that none of these economists thought that Keynes’ ideas were related to wage or interest rate rigidities, or that the problem with the Depression was that wages were too high.

These ideas only became dominant after Hicks and Modigliani, and were popularized in Samuelson’s neoclassical synthesis. In fact, it was the neoclassical synthesis, and not General Equilibrium, that made neoclassical economics the dominant approach in the US. The new economists were trained basically in Marshallian micro (partial equilibrium consumer and production theory) and Keynesian macro (Keynesian cross and ISLM). Old institutionalism started to vanish. [And by the way that is fundamentally, with the addition of natural rate ideas, and a Phillips curve in the macro part, what is essentially taught to undergrads; General Equilibrium is a graduate thing].

Krugman correctly criticizes Barro for the interpretation that the problem for Keynes was high wages, and that monetary policy was the solution. But he says: “if that’s all that it was about, the General Theory would have been no big deal.” Note that neither is a correct interpretation of the GT. Krugman having been trained as an old Keynesian, in the neoclassical synthesis (even if it is very likely that Rational Expectations were already important in his graduate training), is okay with the notion that Keynes believed in some sort of rigidity. For him, contrary to Barro, the main rigidity is not in the labor market, but in the capital market. Namely: a rate of interest that is too low and cannot be reduced further.

I should say here that it is a bit amazing that the discussion does not even include a footnote on Keynes and Pigou effects, and how wealth effects according to the neoclassical authors reestablished the notion of full employment equilibrium, and Keynes’ own views in chapter 19, and Kalecki’s famous reply to Pigou. Not even a footnote on Patinkin’s work on the topic. And that in a nutshell is the problem with Krugman’s paper. He gets stuck with two interpretations the uncertainty version of chapters 12 and 17, and the neoclassical synthesis of chapter 18, but he never bothers with chapter 19, the first in the whole book in which flexible wages and prices are allowed, and still no full employment is reached.

That’s why is weird that he thinks that Keynes didn’t say anything about debt. In chapter 19 Keynes says:
“the depressing influence on entrepreneurs of their greater burden of debt may partly offset any cheerful reactions from the reduction of wages. Indeed if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, — with severely adverse effects on investment.”
Debt deflation is integral to Keynes' analysis. And that’s why Krugman has to reinvent what was already known (redundant originality one could call it), but put it into a New Keynesian model (his paper with Eggertsson cited in p. 18), which further complicates the issues, since New Keynesian models assume a natural rate and a tendency to it, that is not reached because of some sort of rigidity. Krugman never learnt the ancients (and I’m not even talking about the surplus approach, but just the old Keynesian tradition).

Don’t get me wrong, as I said about the DeLong in another post, Krugman has been essential to debunk a lot of crazy ideas, and support adequate policies. But it is a problem when the reasonable people in the mainstream still use a model that is basically self-adjusting to full employment.

I would not venture a full explanation of why this happened. But my hunch is that the defeat in the capital debates of the 1960s, admitted by Paul Samuelson, which among other things showed the impossibility of having a natural rate of interest (the existence of a rate of interest low enough that would provide full utilization of capital, something that Keynes knew it was important, saying so in the GT, but was unable to obtain because of his insistence on the concept of a marginal efficiency of capital), the dominant approach turned to eclecticism. This meant that Arrow-Debreu General Equilibrium (a short run equilibrium solution) provided the totem for the idea that markets work and are efficient (freeing the radical market fundamentalists to unleash the Rational Expectations revolution, for which markets always clear), while more reasonable authors (still within the mainstream, like Krugman) developed several research agendas on the basis of finding imperfections.

While one might agree with several policy propositions by the more reasonable mainstream authors (we need fiscal stimulus and the debt ceiling is not a real problem being two of those), it is important not to forget that their theoretical stance is deeply flawed. For more on this see my paper on a forthcoming edited book on the 75th anniversary of the GT.

Friday, June 17, 2011

Is Growth in China Investment-Led?


The general confusion, in both the mainstream and some heterodox groups, about the Asian development model is surprising, to say the least.  Martin Wolf, in a recent column (subscription required or here for free), says regarding the Chinese growth prospects that:
"Happily, China has close cultural and economic similarities with these east Asian successes. Unhappily, China shares with these economies a model of investment-led growth that is both a strength and a weakness. Moreover, China’s version of this model is extreme. For this reason, it is arguable that the model will cause difficulties even before it did in the arguably less distorted case of Japan."
The notion is that high rates of savings, associated to repression of consumption, and the absence of a social welfare net, lead to high rates of investment, which explain the incredible performance of Asian economies over the last 60 years or so, starting with Japan, followed by the Tigers, and then China.  The danger would be that, as the share of consumption grows, and:
"this pattern of growth is to reverse, as the government wishes, the growth of investment must fall well below that of GDP. This is what happened in Japan in the 1990s, with dire results."
Although, it is not quite expelled out, one would imagine that the problem is that with higher levels of consumption not enough savings would be left to 'finance' investment.  Further, the argument in the column suggests that as a result of the high levels of investment, returns "at the margin" are low, and "much of the investment now undertaken would be unprofitable."

In heterodox circles there used to be talk about an investment-profit nexus in the Asian development model. This was the main point of a famous paper by Akyuz and Gore (subscription required). The idea was that government policy accelerated the process of capital accumulation by creating rents and pushing profits over and above those that could be attained under free market policies, and higher profits generated incentives for investment and economic growth. Also, Asian economies displayed an ability to upgrade exports continuously through the "flying geese" path, and to their ability to generate the high levels of savings and investment required for this upgrading.

Further, Gabriel Palma, a well known heterodox economist at Cambridge University, argued that savings in an economy, necessary for capital accumulation and investment in his view, is not voluntary or spontaneous but needs a governmental role and that the general failure in Latin America to grow as fast as East Asia results, in part, to the fact that domestic savings have gone into consumption and not in investment. In other words, while the frugal Asian elites invested like ants, the spendthrift Latin American elites emulated the patterns of consumption of the developed world, like the grasshopper (see for example his paper on the Chilean bourgeoisie here; subscription required).

There are problems with both the neoclassical and the heterodox accounts of the Asian development model.  The conventional model suggests that the flow of savings somehow funds, investment.  Somebody should show this people the System of National Accounts (SNA-2008), which shows that savings are a residual.  Further, if the model shifts from export-led to domestic demand-led, in particular with higher levels of consumption, investment will continue to react, through the accelerator, and will not stop growing.  If consumption grows faster than output, and its share increases, either investment, government consumption or net exports, as shares will have to fall, but that would not signal any particular problem to the growth process.  Investment is the result of growth, in Asia as in any other part of the globe.

One possible danger is that if net exports become negative, an external constraint may become binding.  However, the Chinese have maintained a closed capital account, and manage their exchange rate, which suggests that there is is clear awareness that external constraints should be managed.  Also, they aggressively have searched sources of inputs, trying to secure favorable trading terms, so that access and ability to pay for imports will not force a slowdown of their economy. So a likely outcome is simply that the consumption share will increase while the investment will shrink, with no significant effect on growth.  The Japanese stagnation has nothing to do with a fall in the share of investment in total GDP, and is related, in part, to the collapse of a financial bubble.

For the heterodox story I suggest reading my post on whether the United States is profit-led. The problem is essentially the same with the general profit-led argument.  The problem is that investment is derived demand.  High profits do not lead to investment if demand growth is sluggish.  The central element in the Asian development model was the growth of exports, and their privileged access to American markets.  Carlos Medeiros (reading in Portuguese here) and Franklin Serrano have referred to this as "development by invitation."  Both the Chinese have benefited from access to American markets, as the Americans, with cheap consumption goods. More importantly for American corporations (besides access to the Chinese and other Asian markets) is the use of relocation as an effective threat against labor at home.

In sum, not only China is not investment-led, but additionally there is no significant risk from a Chinese development strategy that is more reliant on domestic sources of demand.  Consumption is not inimical to growth, particularly if it results from sustained increases in real wages, rather than the accumulation of private debt, as in recent American booms.  That is the Chinese challenge, to incorporate an increasing number of workers into the formal economy with higher real wages.

Thursday, June 16, 2011

Retire at 55


Jamie Galbraith says that the United States is short about 16 million jobs compared to what the economy would need to have. His solution is simple.  He suggests opening a three-year window allowing boomers to retire at 55 with full benefits to boost the economy. There is a short radio interview here.

Wednesday, June 15, 2011

Keynes' False Dawn

Jamie Galbraith paints a grim picture of the short lived infatuation with Keynes in policy circles after the crisis.  He says:
"In the high crisis just two years back, the cult of John Maynard Keynes saw a dramatic revival. Deficits were acceptable, stimulus plans became law, books entitled Return of the Master and The Keynes Solution rushed into print. Enthusiasts spoke of a “new New Deal.” Today, although the economy has not recovered, and although unemployment remains near 9 percent, none of this remains.

Barack Obama declined to become a third Roosevelt. His Bernard Baruch proved to be Robert Rubin. There is no Wagner in the Senate, no Eccles or Currie at the Federal Reserve. The agencies that harbored Leon Henderson and the young John Kenneth Galbraith do not exist. If Keynes were alive today and came to visit, one wonders who in official Washington would see him.

The new dawn of the Keynesian idea has gone dark."
He suggests that the reasons are not associated to the radicalism of Keynes' ideas, but to the fact that there is no economist with the kind of influence that Keynes had back then.  In his words:
"It wasn’t that he taught that that thrift is a vice, or that savings are pathological, that deficits are helpful, that debt is necessary, that interest rates should be kept low, that the economy should be run at full employment for the good of all. It wasn’t even his reference at the end of The General Theory to the 'euthanasia of the rentier.'

No, it was the fact that Keynesian policy required Keynes. And if Keynes were in charge, then the captains of industry could not be. Larry Summers is not Keynes. But he did give the impression, for a while, of running the show. This was a fatal error. It was the impression of making policy that business and the Tea Party could not stand. A better policy would not have been better liked.

With Jeffrey Immelt, we now have a business face and no economic policy at all. The president has learned. Whether it will save him be remains to be seen. A full government of business people would be much more authentic."
In other words, Immelt and business types are behind economic policy, and Summers is less influential than Keynes was.  Not sure I agree with this one.  Keynes wasn't that influential during the 1920s and 1930s, in neither side of the Atlantic.  And the likes of Baruch, Currie, Eccles, and Wagner, responded more to common sense than to Keynes theories.  Further, Summers is part of the problem (even if he gets that we need more stimulus), because he was instrumental in the process of deregulation.  I think the main problem in the US is that Democrats are now, and since Carter (reinforced by Clinton), the other party for business.  There is no people's party, somebody for higher wages, strong unions, and full employment.  In that context, Keynes' ideas had no real chance.

Tuesday, June 14, 2011

Reckless lack of discipline?

You expect the IMF, and other conservative institutions and economists, to come up with the same old sound finance stuff. It is more distressing when Dr. Doom (as Nouriel Roubini is known among his friends) says, on an otherwise reasonable column  (subscription required) about the likely break up of the eurozone, that interest rate convergence led to "a reckless lack of discipline in countries such as Greece and Portugal." The point is that at least in these two countries the problem was fiscal, and not the euro, the lack of competitiveness and speculative bubbles.

The graph above shows the primary balance in Germany and the three little PIGs that were forced into ECB/IMF adjustment programs (yep, the big bad wolf in this story). Primary balances show the difference between spending and revenue, excluding interest payments. Note that Ireland had surpluses until the crisis, and Greece and Portugal are not substantially different than Germany until the crisis. And the worst deficits after the crisis take place in Ireland, the most well behaved according to sound finance. Can we check the data before we write about the crisis?!

Wednesday, June 8, 2011

What is the correct Keynes solution


Paul Davidson at Triple Crisis.  Most of the post is about Keynes' views on money, and how, contrary to the mainstream, for Keynes money is not neutral. He says:
"In Keynes’s solution to our global economic problems, the primary function of well organized and orderly financial markets is not to optimally allocate capital. Instead it is to provide liquidity so that holders of financial assets traded on such markets “know” he/she can make a fast exit and liquidate their portfolio position at a price close to the previous market price at any time he/she fears something bad is going to happen in the future. For business firms and households the maintenance of one’s liquid position is of prime importance if bankruptcy is to be avoided. In our world, bankruptcy is the economic equivalent to a walk to the gallows."
True, but the important point now is that we are at an Eccles' moment.  In other words, monetary policy is like "pushing on a string."  We need fiscal policy, and to understand that deficits and debt are not a problem, they are the solution.

Always hopeful for signs of intelligent life


And usually disappointed. However, I awoke early, and before my brain was adequately caffeinated, stumbled into a place I wouldn't normally venture (h/t Mark Thoma). And, wonder of wonders, found, ummm, maybe embers of economic intelligence.

The source may not surprise the less cynical reading this, but it certainly surprised me: Bill Dudley, President of the Federal Reserve Bank of New York, owner of open market operations, and permanent member of the FOMC. Bill addressed the Foreign Policy Association, and his text is worth reading.

Especially the section about half way down, where he clearly explains the policy implications of (but doesn't attribute) Wynne Godley's triple balance stock flow consistent approach.

And he understands the challenges of rebalancing the world economy.

He doesn't spend quality time on debt sustainability, caving to the current austerian meme for the most part, and thus does not tackle the unemployment equilibrium/deficient effective aggregate demand problem in the U.S. and other developed economies, which is the dog that will increasingly wag the fiscal and financial tail.

But it seems to me there are signs of intelligent embers here. Spoken in public. Will it matter?

Tuesday, June 7, 2011

Rogoff on the euro and common currencies



Ken Rogoff wrote a peculiar op-ed (subscription required) on the euro.  He correctly points out that the euro is very close to breaking up, and that the alternative would be to "deepen into a fiscal union."  His comment on what exactly the fiscal union would mean is criptic.  He says that the euro would fail "because European leaders are constitutionally incapable of making tough decisions on how to trim periphery debt burdens."  Does he mean that the fiscal adjustments imposed on the periphery are not tought enough? Or is he favoring a renegotiation of the debts, admiting that they cannot be paid?  It seems that his options are either more fiscal adjustment or default.

Default could be an option, don't get me wrong, in particular, because the ECB is not going to monetize the debt of the periphery.  But the interesting thing is that, either way, he does not even consider that the debts in the periphery are in euros, and the ECB can actually print euros.  And I won't explain again why that shouldn't be a problem (like in the US; read more here).  The 'debt' problem in Europe is only a problem, because the ECB allowed a domestic debt, in which there is no default, to become an external debt problem.

Rogoff also muses about the possibility of a common North American currency bloc "possibly extending to include a significant part of Latin America."  I would assume that he does not mean a common currency, or votes in a common central bank, but just dollarization.  Or is the former chief economist of the IMF suggesting that the US will reliquinsh its own currency? Not very likely!

He concludes, in very conventional fashion that:
"Having a smaller number of currencies is a phenomenon that makes a lot of sense economically, economising on transactions' costs and leveraging economies of scale.  The real questions is whether common currency is sustainable politically."
In other words, the economics would be fine, but it is the lack of political will to make tough decisions as he said before, that make the euro unsustainable.  This is nonesense.  Common territorrial currencies are not important because they reduce transaction costs, and that is not the reason why they appeared.  Territorial currencies appear because a strong State can enforce the use of particular token to promote domestic expansion (in general of a particular class), and guarantee the secure functioning of the financial system (to fund the State) providing a default free asset.

At this juncture the problem of the euro is an economic one.  The countries in the periphery eliminated one instrument to deal with their external problems (current account deficits), and are forced into adjustment for that reason.  No amount of political will would solve that under the conventional logic according to which monetization of debt is inflationary.  At a deeper level common curreencies are always a political project, and once political unity exists  there is no economic problem with having a common currency, because fiscal transfers allow for subnational units to avoid default, and the federal government becomes responsible for fiscal policy.

This is not the story of weak and corrupt politicians destroying the good functioning of the market economy; this is a story of haywire markets forcing politicians to do terrible things. Some politicians wanted to do this terrible things even in the absence of the euro (see the fiscal adjustment in the UK, for example).  Shame on them for doing it, but shame on economists for pushing this sort of intellectual drivel.

Monday, June 6, 2011

Many Economies, Just One Medicine

The IMF in its last Fiscal Monitor suggests that developed countries must adjust because public debt is growing out of hand, and Latin American (and other developing regions) should do fiscal adjustment because their economies are overheated.  First, the graph below shows public debt in four developed countries.  It is clear that in all debt-to-GDP ratios went up after the crisis.  In other words, public debt is the result of the crisis not is cause.

It is important, also, to remember that the crisis has destroyed private wealth (even though governments went out of their ways to compensate some for their losses, in particular the big banks that got us into the crisis).  If private debt falls, and with it private demand, then public demand (spending) has to increase to compensate, unless one wants lower levels of activity.  So it is far from clear that the increase in public debt is problematic at all, and surprising that the “reformed” IMF already is pushing for contraction (note that the IMF has a central role in promoting brutal fiscal adjustments in Eastern Europe and the periphery of the euro too).

But what is really interesting is that if increasing public debt is a sign of dangerous fiscal profligacy, one would expect that Fund to at least be more lenient with countries that have constant or decreasing public debts.  The figure above shows the case of four Latin American countries.

In other words, if debt increases do fiscal adjustment. If debt falls do fiscal adjustment.  I’m starting to think the IMF is always for fiscal adjustment.  Instead of Dani Rodrik’s One Economics, Many Recipes, their motto is Many Economies, Just One Medicine.


Friday, June 3, 2011

Glenn Hubbard's family



Mark Blyth sent a nice letter  (subscription required) to the Financial Times.  You must remember that "Give it your Best Shot" Hubbard (of Inside Job fame) was the Chairman of Bush's Council of Economic Advisors, and a cheerleader of tax cuts for the very wealthy.  Hubbard had written an op-ed in the FT (no need to read it, since it's really bad) saying that public debt is out of control.  Of course he is still against taxes for the wealthy.  First Mark gets correctly the point that public debt is not analogous to private debt and lectures the economist (that should have known this):
"the Hubbard family does not issue its own script, owe itself money, borrow other people’s savings with their own paper, or allow new entrants into the family on the basis of skills and contribution to taxes."
Then he points out that:
"the blame for the current predicament lies in the “discretionary spending binge of the past decade”, which would be the cost of bailing the banks that he argued should be less regulated, and the unfunded tax cuts which he championed. Odd then that having cut into revenue so drastically Professor Hubbard resists raising it through taxes, especially on the top 1 per cent, who, even if we were to double their share “would not right the fiscal ship”. Perhaps, but since they made off with 20 years of gains, and got their assets bailed, I’d just feel a bit more part of the family if they did."

Here is another case of a Republican economist caught between the logic of the problem at hand and their bizarre solutions.  Before anybody complains, I'm not to worried about the size of debt, or the fact that is growing, but I'm in favor of higher taxes for the rich.

Thursday, June 2, 2011

Lucas and Intelligent Design


A friend send me Lucas' Milliman Lecture at the University of Washington (Krugman commented here).  Lucas argues that this crisis was like the depression the result of a significant monetary contraction (he believes in Real Business Cycles, RBC, but only when it is convenient apparently), and suggests that Friedman and Schwartz Great Contraction interpretation of the Depression is correct.  For him recovery was slow (in spite of unemployment falling from almost 25% to around 9% from 1933 to 1936!) because the government intervened and demonized businessmen.  This is basically the same piece of ideological propaganda that Amity Shlaes in her book The Forgotten Man (terrible book, by the way) has been pushing around.

Certain things have to be said again and again because some people keep repeating lies until they become credible.  The New Deal did work (see here)!  Unemployment did fall significantly, and when they tried fiscal adjustment in 1937 (fall in expenses associated with pensions for WWI veterans, and new taxes associated to the Social Security Act) the economy contracted.  There is a reason why everybody in the profession became a Keynesian in the 1940s; because it worked, and the war economy was the ultimate proof of it.

In Lucas' view, recovery depends on the confidence of businessmen.  The question that people that believe in what Krugman aptly calls as the Confidence Fairy have to reply is why would businessmen invest if the economy is in the dumpster, and there is no demand for their goods, let alone to create new capacity by buying machines!  And should I also add that the evidence for investment is that it follows output?!  Logic and evidence have no relation with the sort of stuff Lucas believes, and he should not be taken seriously.

I'll quote again Marriner Eccles, the chairman of the Fed during the Depression, and a Republican from Utah, on the subject of confidence.  He said:

"Confidence itself is not a cause. It is the effect of things already in motion. (...) What passed as a 'lack of confidence' crisis was really nothing more than an investor's recognition of the fact that new plant facilities were not needed at the time."

And Eccles actually knew a thing or two about running real businesses.  Put clearly, lack of confidence is the result of lack of demand.  We need more stimulus, and confidence will return.

Lucas had a poisonous effect on the profession, leading it back to the dark ages of macroeconomics.  He wants now to push the same sort of inane idiocy in the policy arena.  He suggests that the slow recovery results from Obama's European style social democratic programs!  Next thing he'll say that Obama is Kenyan.  Lucas and the New Classical Rational Expectations (and RBC) School are the intelligent design of economics.  They should have the same status in the scientific community.


Wednesday, June 1, 2011

Is there a European crisis?


Jamie Galbraith has his doubts that the crisis in Greece and other peripheral European countries should be called European.  You can hear the audio of his talk here.  His point is that, while it is true that the European confederate organization with weak fiscal links is a problem, the crisis was a global financial crisis with the epicenter in the United States.  The European problem is that the model of integration is a failed one to bring the convergence of the periphery to the income per capita levels of Germany and France.